Form 990: top 10 areas of focus for board members

While it is not imperative for every board director, officer and key employee to be independent, and while lacking independence is not fatal to the role that those individuals play on behalf of the organization, lack of independence does raise a red flag and begs the question of who is looking out for the public’s (rather than private) interests.

The Form 990 contains a number of questions that touch upon independence.

Page 1, Part I, lines 3 and 4 and Page 6, Part VI, lines 1a and 1b

List both the number of total board members and independent board members. Board directors should be aware of the definition of independence and whether or not they have any transactions or compensation that would render them non-independent.

Page 6, Part VI, line 2

Queries whether or not board directors, among others, have family and/or business relationships with other board directors/officers/key employees. Any board director with a family or business relationship will want to closely analyze whether or not the relationship creates a lack of independence.

Page 6, Part VI, lines 12a through 12c

Provide detail on the organization’s conflict of interest policy and procedures to ensure that an independent review is conducted of transactions that key insiders engage in with the exempt organization over which they have substantial influence on terms favorable to the insiders.

This question also relates to board director independence by illuminating the organization’s ability to ensure that all management and board- level decision making is ethical and objective.

Schedule L, Part IV

Requires reporting of transactions between “interested parties” and the organization, highlights board director transactions that potentially render directors non-independent. An understanding of the various thresholds necessary for reporting is crucial to ensuring that no reportable transaction is inadvertently omitted.

Page 2, Part III, line 1

States the board-approved mission. The IRS expects that the organization’s activities should reflect the mission. Does the mission itself drive the activities? “Mission creep,” whereby the organization slowly drifts from its original intent, could provoke the IRS into revoking an organization’s exemption, regardless of whether the activities are of an exempt nature.

Pages 2, Part III, lines 4a-4d

Asks the organization to expound on its activities. Do these explanations tell prospective donors, grant makers and the public what value to the community that the organization’s existence provides? Do the explanations provide convincing evidence that

the organization deserves or warrants continued tax-exempt status by the benefits it provides to the beneficiaries of its services, stakeholders, and the community as a whole? Do the explanations convince potential donors that their contributed dollars would go to a worthy organization?

If it doesn’t, it should. This is a prime opportunity to sell the world on the organization that board directors represent. Quantitative and qualitative information should be provided to induce the reader into believing in the mission as much as the organization itself does. Use the space wisely and completely. This is where the organization should shine the brightest, where verbosity should replace brevity.

Parts IV, V and VI

Touch on various compliance and governance issues of which board directors should be keenly aware.

Pages 3 and 4, Part IV

Lists questions that, if answered yes, require additional information be provided on various schedules which then become part of the form for filing purposes. Note that the omission of a schedule is treated by the IRS as an incomplete filing, which to the IRS means no return has been filed at all. The penalties related to non-filing can quickly escalate – it’s important that board directors ensure that all necessary schedules have been filed.

Page 5, Part V

Serves as a reminder to organizations that they have various information filing requirements which must be fulfilled. Are they providing the requisite forms reflecting payments and payroll to independent contractors and employees alike? Have they identified and reported unrelated business income? Do they understand the threshold for acknowledging contributions from donors, particularly when goods and services are also provided? Note that not providing adequate acknowledgement to a donor may have adverse consequences to the donor as well and result in both compliance and public relations issues for the tax-exempt organization.

Board directors must be active in ensuring that organizations under their responsibility fully comply with all filing requirements or risk fines and penalties.

Page 6, Part VI

Imparts insight to the Form 990 reader on the organization’s governance structure and strength. Section A, lines 1 through 9, highlight whether or not the organization delegates important duties to outsiders, defines member powers, and if there has been a diversion of assets during the fiscal year.

Section B, lines 10 through 16

Requires the organization to disclose the existence of certain policies and procedures, the first of which is the Form 990 review process. It can’t be emphasized enough that all board members should be provided access to a copy of the Form 990 before the Form 990 is filed with the IRS.

If an organization does not provide a full copy (with Schedule B included) to its entire board, the IRS may consider the lack of access a red flag signaling other governance flaws.

Board directors should also insist on reviewing the return or, as most organizations do, delegating that responsibility to a committee (audit, finance or executive).

Other policies that the IRS views as important and strongly urges exempt organizations to adopt include conflicts of interest, whistleblower, document retention and destruction, and compensation. Note that while these are not required by law, the IRS considers these best practices. In particular, compensation policies are being heavily scrutinized by the IRS.

Page 6, Part VI, lines 15a and 15b

Asks for a narrative on the compensation process.

Board directors should pay particular attention to the organization’s compensation process as it is critical for the organization to be able to defend its officer/key employee salaries against IRS accusations of excessive compensation.

Remember that intermediate sanctions penalties that the IRS can impose in connection with excessive benefit transactions may be assessed against an insider, the exempt organization and the board directors personally.

The three rebuttal presumptions against excessive compensation are:

1. Using comparable information in determining compensation
2. Ensuring that relevant comparables are used by the governing body as the basis for their compensation decisions
3. Documenting decision making on compensation in board or committee minutes

Pages 7 and 8, Part VII

Discloses board directors, officers, key employees and highly compensated employees. All compensation from the filing and related organizations is to be reported on a calendar year basis regardless of the fiscal year of the filing organization. This is the first of two places on the Form 990 in which compensation is displayed.

Schedule J, Parts I through III, likewise reports on compensation policies including:

Part I, line 1

Lists a number of benefits which may be provided to officers/key employees. Board directors should be aware when negotiating with potential management personnel that some benefits afforded to officers and key employees may have potential adverse ramifications if provided on a tax-free basis.

Part I, line 3

Requires disclosure of which methods are used to set compensation for key employees and highly compensated employees. Ideally, the organization’s practices should allow it to fill up many of the boxes included in the question.

Part I, lines 5 and 6

Also refer to bonus arrangements which may escape the boundaries of safe harbor regulations. Bonus programs should be closely monitored to ensure that bonuses are not determined on a basis considered prohibited under IRS rules.

Pages 9 through 12, Parts VIII through XII Enumerate the organization’s financial position. This information should mirror, in its entirety, the audited financial statements with some adjustments. The biggest exposure item embedded in these pages is the potential for undisclosed unrelated business income, or UBI.

While there are many exceptions to the UBI rules, board directors should understand that UBI is measured on an activity-by-activity basis, and ensure that any revenue not explicitly program- related has been analyzed and documented for its relative propensity to be considered unrelated.

Page 10, Part IX

Exhibits the functional expenses. Board directors should be aware that the percentage of program service expenses versus management/general and fundraising is a critical factor with various charities’ rating websites and may contribute or detract from the public’s perception of the organization’s value.

Schedule D, Parts XI and XII

Calculate the “book-to-tax” differences relative to a not-for-profit organization. These reconciliations will assist board directors and stakeholders in relating the financial statements to the tax return.

Board directors of charitable organizations should generally know under what rules the organization derives its public charity status. In particular, there are potential issues with regard to maintaining public charity status for so-called publicly supported organizations.

Schedule A, Parts II and III

Highlight the public support calculation. Board directors should understand just how critical it is to meet these tests. Failure to meet the

33 1/3% threshold may cause the entity to be re-characterized as a private foundation. Note that board director/officer/key employee/ substantial contributors’ donations reduce the public support percentage.

Schedule C reports on the organization’s lobbying activities. Most not-for-profits, particularly charities, are limited in their ability to lobby and/ or involve themselves in the political process. It is imperative that any contact, either grassroots or through third-party organizations, be carefully monitored to ensure the organization does not participate in prohibited actions or spend too much time/resources on lobbying activities.

Schedule F serves as a reporting form for the organization’s foreign activity. However, it does not replace the various foreign reporting forms that not- for-profit organizations may need to file based upon their investment activity. Board directors should be aware that having a diverse portfolio could generate the necessity of foreign reporting requirements, particularly the use of partnership interests in wide-ranging hedge fund-type investments that could generate tax liabilities and penalties. The omission of required foreign filings carries punitive penalties which can be difficult to waive once assessed.

Schedule K details bond issues and the organization’s compliance surrounding the issue itself and its ensuing use. Board directors should understand the gravity of not having written procedures for post-bond issuance compliance. The IRS has implied it will give organizations without written procedures related to private business use and arbitrage, nonqualified bond remediation and VCAP intense scrutiny during the audit process. Board directors should consider instituting these policies a high priority. Given the technical nature of bond issues and the potential loss of exemption for the issue, it is important that charities with tax exempt bonds work in concert with their tax advisors and bond counsel.

Schedule R, Parts I through IV

Provide a window into an organization’s structure by encapsulating into four categories all of the entities which meet the rules for being related to the filing organization.

Part V, lines 1a through 1s

Capture intercompany transactions by listing a multitude of potential interactions between the filing organization and its parent/brother/sister organizations. Board directors should pay particular attention to line 1a, which references interest/rents/royalties/dividends from controlled entities. Such transactions may be considered unrelated business income by the IRS under specific circumstances.

For charitable hospitals, the changing landscape ushered in largely by the Affordable Care Act provisions has rendered the Schedule H a substantial undertaking. In a nutshell, Congress and the IRS have required a great amount of disclosure and transparency to ensure that charitable hospitals warrant continued charitable status based upon the degree to which they give back and contribute to the communities that they serve. Community benefits, community needs assessments, financial assistance policies, and debt collection policies and practices are at the forefront of the discussion. Board members of charitable hospitals should be familiar with those terms and those practices in their oversight of the hospital organization.